STRATEGIC CAPACITY MANAGEMENT CHAPTER 3

Learning Objectives After completing the chapter you will: Know what the concept of capacity is and how important it is to manage capacity over time Understand the impact of economies of scale on the capacity of a firm Understand what a learning curve is and how to analyze one Understand how to use decision trees to analyze alternatives when faced with the problem of adding capacity Understand the differences in planning capacity between manufacturing firms and service firms

Shouldice Hospital Dr. Edward Earle Shouldice: a major in the army, & an expert in hernia surgery In 1945, his reputation made him open a hospital dedicated for hernia surgery after the War. In 1953, the second hospital was open for increased demand. Today, repeated development has culminated in the present 89-bed facility.

Strategic Capacity Planning Capacity  the ability to hold, receive, store, or accommodate Strategic capacity planning  an approach for determining the overall capacity level of capital intensive resources, including facilities, equipment, and overall labor force size

Capacity In a more general business sense, capacity is:  The amount of output that a system is capable of achieving over a specific period of time.  In service: # of customers that can be handled in an hour.  In manufacturing: # of automobiles that can be produced in a single shift.

Capacity from OM view Need to look at both resource inputs and product outputs. Real capacity depends on what is to be produced. Ex. (an automobile company)  Resource inputs: 6,000 production hours  Product outputs: 150,000 two-door models or 120,000 four- door models or some mix of two

Capacity from OM view (cont.) An OM view emphasizes the time dimension of capacity. i.e. Capacity must be stated relative to some period of time. Three time durations of capacity planning  Long range: > 1 year. Long-time acquiring or disposing productive resources (building, equipment, facility)  Intermediate range: monthly or quarterly plans for the next 6 to 18 months. Hiring, layoffs, new tools, minor equipment purchases, and subcontracting  Short range: < 1 month. Daily or weekly scheduling process and making adjustments. Overtime, personnel transfers, alternative production routing

Capacity from OM view (cont.) Capacity  The amount of resource inputs available relative to output requirements over a particular period of time. Consistent with “maximum practical capacity”  Output attained within the normal operating schedule of shifts per day and days per week including the use of high-cost inefficient facilities”

Strategic Capacity Planning Objective  To provide an approach for determining the overall capacity level of capital-intensive resources that best supports the company’s long-range competitive strategy. The capacity level has a critical impact on…  Response rate  Cost structure  Inventory policies  Management and staff support requirements

Capacity Level If inadequate (i.e., slow service, or allowing competitors),  Lose customers If excessive,  Price reducing for demand  Workforce under-utilizing  Excess inventory carrying  Additional, less profitable products seeking

Capacity Utilization Where Capacity used  rate of output actually achieved Best operating level capacity for which the process was designed  i.e. the volume of output at which average unit cost is minimized

Best Operating Level Example: Engineers design engines and assembly lines to operate at an ideal or “best operating level” to maximize output and minimize ware Underutilization Best Operating Level Average unit cost of output Volume Overutilization

Example of Capacity Utilization During one week of production, a plant produced 83 units of a product. Its historic highest or best utilization recorded was 120 units per week. What is this plant’s capacity utilization rate?  Answer: Capacity utilization rate = Capacity used. Best operating level = 83/120 =0.69 or 69%  Answer: Capacity utilization rate = Capacity used. Best operating level = 83/120 =0.69 or 69%

Economies of Scale As a plant gets larger and volume increases, the average cost per unit of output drops.  Double capacity equipment does not cost double to purchase or operate.  Plants get efficiencies when large enough to utilize dedicated resources.

Diseconomies of scale At some point, the size of a plant becomes too large and diseconomies of scale become a problem.  To keep the large facility busy, significant discount may be required. (U.S. auto industry)  Minimizing downtime of large-capacity equipments (M&M Mars)

Economies & Diseconomies of Scale 100-unit plant 200-unit plant 300-unit plant 400-unit plant Volume Average unit cost of output Economies of Scale and the Experience Curve working Diseconomies of Scale start working

The size of a plant May not be influenced by internal equipment, labor, and other capital expenditures. A major factor may be  The cost to transport raw materials to the plant  The cost to transport finished product from the plant Ex.  Cement factory  Japanese automobile companies  The anticipated size of the intended markets will largely dictate the size and capacity of the plants

Diseconomies of scale Jaguar Case  Found that they had too many plants  14 cars per employee  In comparison,  Volvo: 29 cars per employee  BMW: 39 cars per employee Larger capacity does not always guarantee more productivity.

The Experience Curve As plants produce more products, they gain experience in the best production methods and reduce their costs per unit Total accumulated production of units Cost or price per unit Yesterday Today Tomorrow

Capacity Focus The concept of the focused factory  A production facility works best when it focuses on a fairly limited set of production objectives.  A firm should not expect to excel in every aspect of manufacturing performance. On the contrary,  Trying to do everything well, by breakthrough technology

Capacity Focus PWPs(Plants Within Plants)  Operationalize the capacity focus concept Each of PWP may have separate…  Suborganizations  Equipments  Process policies  Workforce management policies  Production control methods Through this, the best operating level for each suborganizationc an be found.

Capacity Flexibility Capacity flexibility having the ability…  To rapidly increase or decrease production levels  To shift production capacity quickly from one product or service to another. Achieving such flexibility by…  Flexible plants  Flexible processes  Flexible workers  Strategies using other organizations’ capacity

Capacity Flexibility Flexible plants  The ultimate in plant flexibility = zero-changeover time plant  A plant can quickly adapt to change  Movable equipment  Knockdown walls  Easily accessible and reroutable utilities A plant with equipment that is easy to install and easy to tear down and move…like old tent-circus

Capacity Flexibility Flexible Processes  Two rapid low-cost product switching tech.  FMS (flexible manufacturing systems)  Easily set up equipment By these approaches,  Enabling economies of scope  Economies of scope exists when multiple products can be produced at a lower cost in combination than they can separately.

Capacity Flexibility Flexible Workers  Flexible workers have…  Multiple skills  The ability to switch easily from one kind of task to another  Flexible workers require…  Broader training  Managers and staff support

Learning Curve Learning curve percentage  As a plant’s cumulative production become double, the plant’s production cost decline by this percentage. Ex. 90% learning curve percentage  Cumulative production 5M burgers & unit cost $0.55 per burger  Cumulative production 10M burger, then unit cost?  90% of $0.55

Learning Curve Theory Three assumptions  The amount of time required to complete a given task or unit of a product will be less each time the task is undertaken.  The unit time will decrease at a decreasing rate  The reduction in time will follow a predictable pattern

Learning Curve Theory Airplane industry  As output doubled, there was a 20% reduction in direct production worker-hours per unit. That is,  100,000 hours for Plane 1  80,000 hours for Plane 2  64,000 hours for Plane 4  … 80 percent learning curve

Two ways to plot Learning Curves Time per unit  Cumulative average cost, progress curve, product learning Units of output per time period  Industry learning

Logarithm Analysis Learning curve equation *  xUnit number  Direct labor hour required to produce the unit  KDirect labor hour required to produce the first unit  n, where b = learning percentage

Plotting Learning Curves Arithmetic Plot

Plotting Learning Curves Arithmetic Plot

Plotting Learning Curves Logarithmic Plot

From Learning Curves to Performance Improvement (Part 1) Proper selection of workers Proper training Motivation Work specialization Do one or very few jobs at a time

From Learning Curves to Performance Improvement (Part 2) Use tools or equipment that assists or supports performance Provide quick and easy access for help Allow workers to help redesign their tasks

Capacity Planning Adding Capacity Capacity Requirements Evaluating Capacity Alternatives

Considerations in Adding Capacity System Balance Frequency of capacity addition Use of external capacity

System Balance Perfect balanced design is impossible  BOLs for each stage differ.  Variability in product demand and processes

Capacity Planning: Balance Maintaining System Balance: Output of one stage is the exact input requirements for the next stage Stage 1Stage 2Stage 3 Units per month 6,0007,0005,000 Unbalanced stages of production Stage 1Stage 2Stage 3 Units per month 6,000 Balanced stages of production

System Balance Balancing it  Add capacity to bottlenecks  Temp ways: Overtime, leasing, subcontracting  Use buffer inventories in front of the bottlenecks  Duplicate facilities Increasingly being applied to supply chain design

Frequency of Capacity Additions

Frequent Adding  Direct costs –removing, replacing, training  New equipment purchasing  Opportunity cost of idling Infrequent Adding  Carry overhead by purchasing excess capacity

External Sources of Capacity Outsourcing  Japanese banks in CA Sharing Capacity  Exchanging aircraft  Airlines sharing routes

Capacity Requirements Forecast  To predict sales for individual products within each product line Calculate capacity requirements  To meet product line forecasts Project capacity availabilities over the planning horizon

Example 3.3 Step 1: Forecasts

Example 3.3 Step 2  Bottle: 3 MCs (each MC 150,000 bottles/year, 2 operators), 6 operators  Plastic: 5 MCs (each MC 250,000 bags/year, 3 operators), 20 operators

Example 3.3 Step 2  MC req. for year 1:  Bottle: 135/150 = 0.9  Plastic bag: 300/250=1.2  Labor req. for year 1  Bottle: 0.9×2 = 1.8  Plastic bag: 1.2×3 = 3.6  Utilization for year 1  Bottle: 135/450=0.3  Plastic bag: 300/1250=0.24

Example 3.3 Step 3

Evaluate Capacity Alternatives Decision Tree  A schematic model of the sequence of steps in a problem Node  Decision node: square  Chance event node: circle Branches  From decision node: alternatives  From event node: events and their probabilities

Evaluate Capacity Alternatives Solving decision tree problems  Backward pass  Calculate the expected value (payoff) at each step  Eliminate all branches except the one with highest expected value

Example 3.4 Hackers Computer Store  What to do over the next five years Three options  Expand the current store  Locate at a new site  Do nothing  Expand option would be reconsidered after 1 year Two states  Strong growth  Weak growth

Example 3.4 Assumptions  Strong growth has 55% probability  A new site revenue  Strong growth: $195,000/year  Weak growth: $115,000/year  Expansion revenue  Strong growth: $190,000/year  Weak growth: $100,000/year  Do nothing revenue  Strong growth: $170,000/year  Weak growth: $105,000/year  Expansion cost: $87,000 (now and a year after)  Move cost: $210,000

Example 3.4

Planning Service Capacity Time  Cannot be stored  Must produce a service when it is needed Location  Must be located near the customer  Must be distributed to the customer first  Must be where the customer is

Planning Service Capacity Volatility of demand  On a service delivery system is much higher than that on a manufacturing system  Services cannot be stored  Great variability in processing time required for each customer  Affected by consumer behavior Service capacity plan increments: 10 to 30 mins.  Vs. in manufacturing: one-week

Capacity Utilization and Service Quality

Context specific optimal utilization  Low rate favorable: emergency rooms, fire departments  100 percent rate: commuter trains, postal sorting operations, sports events, stage performances Airline case  Use high utilization rates to their advantage

Question Bowl The objective of Strategic Capacity Planning is to provide an approach for determining the overall capacity level of which of the following? a. Facilities b. Equipment c. Labor force size d. All of the above e. None of the above

Question Bowl To improve the Capacity Utilization Rate we can do which of the following? a. Reduce “capacity used” b. Increase “capacity used” c. Increase “best operating level” d. All of the above e. None of the above

Question Bowl When we talk about Capacity Flexibility which of the following types of flexibility are included? a. Plants b. Processes c. Workers d. All of the above e. None of the above

Question Bowl When adding capacity to existing operations which of the following are considerations that should be included in the planning effort? a. Maintaining system balance b. Frequency of additions c. External sources d. All of the above e. None of the above

Question Bowl Which of the following is a term used to describe the difference between projected capacity requirements and the actual capacity requirements? a. Capacity cushion b. Capacity utilization c. Capacity utilization rate d. All of the above e. None of the above

Question Bowl In determining capacity requirements we must do which of the following? a. Address the demands for individual product lines b. Address the demands for individual plants c. Allocate production throughout the plant network d. All of the above e. None of the above

Question Bowl In a Decision Tree problem used to evaluate capacity alternatives we need which of the following as prerequisite information? a. Expect values of payoffs b. Payoff values c. A tree d. All of the above e. None of the above

Summary Capacity, Capacity Management Capacity Planning Concept  Economies of scale  Capacity focus, flexibility Learning Curve Capacity Planning  Capacity requirements  Evaluate capacity alternatives Service Capacity

End of Chapter 3